Tax credits to dwindle

Deloitte superannuation partner John Randall: What people are expected to watch very carefully when they sell property assets is both their income and any other gains they may earn in the year they take a big profit.
Photo: Rob Homer

The government’s new taxes on superannuation investment earnings in the pension phase will not only generate tax revenue on income and capital gains but also save money when it comes to refunding tax-concessional amounts like dividend imputation tax credits.

One of the big current entitlements enjoyed in the pension phase by do-it-yourself super funds and large funds offering access to direct shares is imputation refunds.

Because they pay no tax on pension investment earnings, super funds with significant direct share portfolios – about 40 per cent of DIY funds – have since 2001 been entitled to full refunds of imputation tax credits.

Where a DIY fund member earns $70,000 worth of share dividends that are fully franked, for instance, not having to pay 15 per cent tax on this income means a potential entitlement to $30,000 of imputation refunds that are paid directly to the fund by the Australian Taxation Office.

While a fund in the accumulation or saving phase is expected to gross up its dividends and franking credit and then calculate 15 per cent tax on this amount before deducting the imputation credits, funds in the pension phase haven’t needed to go though this exercise.

They simply add up the franking credits attached to their dividends and expect this as income.

This entitlement won’t be as generous under the new rules in situations where a super pensioner retiree earns more than $100,000 a year, says Deloitte superannuation partner John Randall.

If a fund earns $70,000 of dividends that are fully franked, he says, the $30,000 of credits will add up to $100,000 of assessable income, with any extra earnings facing tax at 15 per cent.

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Say the fund earns another $20,000 on behalf of the member. While the tax on the income beyond $100,000 will come to $3000, the $30,000 worth of franking credits refund will cover this but reduce to $27,000.

It will allow the government to reduce its refund obligations.

Randall says while many super pensioners won’t notice that their fund has received a lower refund because any refund money will go directly from the ATO to the fund, it will nevertheless mean less income for the fund.

Whereas lower imputation credit refunds will apply as soon as DIY funds in the pension mode become liable for tax on amounts above $100,000 from July 2014, the big investment planning exercise for funds will relate to potential capital gains on either shares or direct property investments.

If a fund already owns a property investment with a significant capital gain, Deloitte’s Randall says, taking a profit next year won’t be taken into account towards the $100,000 income threshold.

That’s because any gains will be quarantined until July 2024.

If this same investment is sold in 2025, then it will be the growth from July 1, 2024, to the 2025 sale date that will be counted as income.

As far as how much of the income will be counted, super capital gains are entitled to a one-third discount, so two-thirds of any gain will be added to taxable income facing tax at 15 per cent.

Super investors who acquire a property after the new tax begins on April 5 will have a choice of either accepting the cost base on the date they acquired the property or the market value of the property when the new tax regime begins in July 2014.

If the property is sold in 2022, for instance, two-thirds of the gain from when the fund bought the property or from June 2014 will go towards the $100,000 of taxable income that will have been indexed by the consumer price index in the years in between.

What people are expected to watch very carefully when they sell property assets is both their income and any other gains they may earn in the year they take a big profit.

Randall says one possible strategy for super investors to deal with future capital gains issue is to move into and out of the pension phase to crystallise any losses on shares or property (if they exist), so they have losses to offset any gains taken during the pension phase.

When super funds enter the pension phase, any losses they make when they sell assets are ignored if they haven’t been recorded during the accumulation phase.

The requirement to acknowledge gains in the pension phase where they take taxable income (including any capital gain) above $100,000 is likely to see super fund members looking for strategies that can identify and utilise loss entitlements.

One entitlement DIY funds have is being able to switch from accumulation to pension phase and back again. Because there is a $100,000 threshold in pension phase before tax is due, another approach for funds could be not to allocate all of their super to the pension phase but keep some in accumulation.

If members have super balances that see them liable for 15 per cent tax in pension, not having all their super in pension mode allows them at least to manage pension investment income in terms of the requirement to withdraw minimum pensions based on the account balance.

Limiting the amount allocated to a pension and leaving loss-making investments to an accumulation account will allow unrealised losses to be better managed.